Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Mango Excellent Media Co., Ltd. (SZSE:300413) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Mango Excellent Media Carry?

As you can see below, Mango Excellent Media had CN¥33.8m of debt at September 2024, down from CN¥172.7m a year prior. But on the other hand it also has CN¥4.96b in cash, leading to a CN¥4.92b net cash position.

How Strong Is Mango Excellent Media's Balance Sheet?

The latest balance sheet data shows that Mango Excellent Media had liabilities of CN¥9.80b due within a year, and liabilities of CN¥211.7m falling due after that. On the other hand, it had cash of CN¥4.96b and CN¥5.42b worth of receivables due within a year. So it actually has CN¥368.1m more liquid assets than total liabilities.

Having regard to Mango Excellent Media's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥57.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Mango Excellent Media has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Mango Excellent Media's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Mango Excellent Media can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Mango Excellent Media may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Mango Excellent Media's free cash flow amounted to 26% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Mango Excellent Media has net cash of CN¥4.92b, as well as more liquid assets than liabilities. So we don't have any problem with Mango Excellent Media's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Mango Excellent Media has 3 warning signs (and 2 which are significant) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.